Broker-dealers today face unique challenges in risk management. The proliferation of electronic trading has generated record numbers of traders and volume. Various risk-taking behaviors of traders complicate companies' credit policies and their risk management process. Real-time risk management software is needed to address the specific needs of today's investment companies.
Market risk has the most direct impact on a firm. Changes in the value of investment instruments directly affect the asset value of trading accounts. While most accounts are well funded, some of them may encounter situations where asset value fails to cover the risk of leverage. To deal with this problem, most firms have established credit policies via so-called margin rules, wherein accounts are classified based on their risk profiles, and assets within the accounts are appropriately margined based on a defined set of rules.
Most exchanges, clearing companies, and broker-dealers have their own margin rules clearly defined. Recently, Standard Portfolio Analysis of Risk (SPAN®) of Chicago Mercantile Exchange (www.cme.com) and Theoretical Inter-market Margin System (TIMS) of Options Clearing Corporation (www.optionsclearing.com) have gained traction in margining future contracts and options. Properly margining each account at the end of a trading day via a back-office batch process is a standard practice. However, by the time a problem has been detected by such a delayed process, significant damage may already have been done. In today's ever-changing markets, real-time detection of margin violations, cross asset types and cross multiple currencies, is needed to control the risk to the firm.
Some financial software vendors, especially those who specialize in real-time systems, have started to introduce near real-time risk management software to meet the demand for intraday risk management. Leveraging the real-time quoting and trading systems, these risk management systems scan thousands of trading accounts to compute financial measures such as asset market values, gains or losses and margin requirements, using real-time prices and trading activities. Risk reports are generated intraday based on these measures to warn risk managers of potential problems. Today's powerful hardware and modern parallel programming models deployed in software make it possible to complete such complex tasks in a very reasonable timeframe. For instance, the Credit-at-Risk (CaR) feature comprised in one aspect of the present invention is capable of delivering such reports every minute.
One of the major challenges facing such surveillance risk management systems is information overload. The vast amount of information generated by real-time data on thousands of accounts makes it impossible for risk managers to digest the important information and act quickly. Software developers have employed many concepts in traditional decision support systems (DSS) as extensions to the core surveillance capability. For example, in one aspect of the present invention, instead of furnishing full risk reports, exception reports based on user-defined criteria may be generated to report a manageable number of problematic items where risk tends to concentrate. Further analytical capabilities may be introduced via drill-down features, where users can navigate to detailed information intuitively via the items highlighted by exception reports. In many cases, the analytical capabilities themselves become extremely valuable in researching problems and recommending appropriate actions.
While risk management is becoming more and more important in the financial industry, many broker-dealers have started to demand instant responses to risk. For instance, some industry sectors are moving from a T+1 margin call policy, where margin calls are made after an end-of-day margin report, to T+0 margin call policy, where margin calls are made as soon as a margin violation is discovered. Further, in trading with highly volatile and highly leveraged instruments, such as futures and foreign exchanges, such real-time risk reporting is necessary to address a risky situation within minutes to limit losses. The availability of real-time risk management systems is a revolutionary force gradually altering how risk management desks operate at broker-dealers.
Another key risk facing broker-dealers is the risk-taking behavior of their own customers, the traders. Increasingly, professional class research and trading software, such as RealTick® (www.realtick.com), are being deployed to retail traders' desktops. These trading tools are the main contributors to today's increasingly electronic trading environment and high liquidity. Yet the impressive firepower of these trading platforms requires equally capable risk management components to regulate the trader's behavior.
Developed upon and extending the traditional approach for pre-trade risk management, real-time margining, today's margin systems embedded in the trading platform can compute margin requirements based on portfolio risk. For instance, RealTick's risk-based margin system scans traders' account positions and pending trades in real-time to compute margin requirements on current positions and pending trades, while recognizing hedged positions such as spreads and covers for margin credits. Accurate pre-trade and post-trade portfolio margins are computed based on real-time price information and are compared to determine if the account has sufficient buying power to cover proposed trades. Furthermore, special margin algorithms are applied to keep the number inline with regulatory requirements and exchange rules. In RealTick's case, instruments on the Milan Stock Exchange are margined using the TIMS method to comply with Italian regulations, while CME futures are margined according to exchange published rules, cognizant of its intra- and inter-commodity spread definitions. This capability makes it nearly impossible for traders to trade into margin call situations, while promptly adjusting their account's buying power depending on the price movements.
The combination of pre-trade risk-based margining and post-trade margin-based risk surveillance is powerful enough to address credit risk imposed by traders in most cases. However, margin rules are usually overly general, incapable of addressing the volatility of individual instruments and the correlating asset amounts. This situation makes the CaR method ineffective in addressing the firm's settlement risk and assessing the firm's capital adequacy. Broker-dealers, especially those who are self-clearing, must employ a statistical method to project such risk. The conventional method used for this purpose is Value-at-Risk (VaR).
VaR measures the worst expected loss under normal market conditions over a specific time interval at a given confidence level. Since gaining popularity in the 1990s, VaR is now widely used to report short-term market risk and to assess capital adequacy of investment companies. Today's risk management practices usually employ one of the three most popular methods for VaR reporting: variance-covariance approach, historical simulation, and Monte Carlo simulation.
One of the key features of VaR is its comparability. Given the size of a portfolio, the greater the VaR, the greater the risk, regardless of the content of the portfolio. This property enables two major applications in risk management: (1) when VaR reports are created for the same portfolio periodically, one can track the level of risk-taking over time, and (2) when VaR reports are created for a number of portfolios at the same time, risk levels of these portfolios can be compared side-by-side. By tracking firm-wide risk over time, management can obtain a strategic view of risk-taking behavior at an aggregated level. This is an important component of financial reporting, as well as of long-term risk management practices. Side-by-side comparison of portfolio risk gives risk managers a tactical tool to analyze risk distribution within an investment domain. Being able to quickly spot areas with the greatest risk concentration gives risk managers a means to act promptly to avoid damages.
The risk management software described herein has gone a step further to add analytical capabilities on top of VaR reporting. One embodiment bundles drill-down capability into its VaR reporting so that users can further examine risk for groups of stocks and options with the same underlying asset, as well as for individual positions, and rank the subsets based on risk level. With only a few clicks, a risk manager can pinpoint key areas that are riskiest to the portfolio. In many cases, what-if scenario analysis tools are also included to assist the risk manager in researching appropriate actions to mitigate risk.
Because of the computational complexity in VaR calculations, most companies use an overnight batch process to generate the reports. This practice is satisfactory for strategic control of the firm risk, but not sufficient for tactical analysis, intraday risk control, what-if studies, and risk-based trading. To enable on-demand VaR reporting, vendors employ various ways to deal with the complexity. An embodiment of the present invention employs an overnight batch process to compute intermediate risk measures, such as volatility and correlations, and real-time prices and positions are used to generate on-demand VaR reports. The practice is so effective that a ten thousand position portfolio can have its VaR computed within twenty seconds.
Many broker-dealers have started to take full advantage of technological advances in real-time risk management software. The pre-trade risk-based margin system nearly eliminates the possibility of having a trader's risk-taking behavior cause a violation of the firm's credit policy. The real-time margin-based risk surveillance makes it possible to catch credit policy violations immediately. The on-demand VaR calculation provides risk managers tools to spot risk concentration and take appropriate action to mitigate risk. After deploying such software packages, many firms see an immediate productivity gain on their risk desks. Over time, risk managers, who are relieved from repetitive routine work now handled by the software, spend more and more time solving complex problems that require human intervention. Some firms also take advantage of the analytical capability of the software to add depth to the level of service offered to their clients. The virtuous loop of lower risk, improved productivity, more intimate client service, and growing business is making risk management practice a profit generator.
In one aspect, the invention comprises a method comprising: (a) acquiring background data regarding securities positions and regarding real-time pricing data; (b) performing calculations regarding intermediate measures of performance of the securities; (c) receiving configuration data for a portfolio of securities and one or more data requests, at least one of the data requests comprising a request for a value at risk report regarding the portfolio; and (d) providing a value at risk report based on the background data, the calculations, and the configuration data, wherein the value at risk report is based on a Parkinson's volatility estimation.
In various embodiments: (1) the step of acquiring background data comprises obtaining real-time data regarding positions from one or more order management systems; (2) the step of acquiring background data comprises obtaining real-time pricing data from one or more market data services; (3) the step of acquiring background data comprises obtaining high-low volatility data based on a plurality of recent trading days; (4) the plurality of recent trading days is approximately ten days; (5) the step of performing calculations regarding intermediate measures of performance of the securities comprises computing implied volatility for options based on a Black-Scholes formula and market prices; (6) the step of performing calculations regarding intermediate measures of performance of the securities comprises computing multi-point risk arrays based on option implied volatility and stock high-low volatility; (7) the step of receiving configuration data for a portfolio of securities comprises receiving the calculated intermediate measures of performance; (8) intermediate measures of performance comprise positions, volatilities, and risk arrays; (9) the step of providing a value at risk report comprises grouping positions by underlying securities; (10) the step of providing a value at risk report comprises aggregating risk arrays; (11) the step of providing a value at risk report comprises aggregating risk arrays for futures positions within each of one or more portfolios and applying correlation coefficients; and (12) the step of providing a value at risk report comprises transmitting the report to a graphical user interface for display.
In another aspect, the invention comprises software comprising: (a) software operable to acquire background data regarding securities positions and regarding real-time pricing data; (b) software operable to perform calculations regarding intermediate measures of performance of the securities; (c) software operable to receive configuration data for a portfolio of securities and one or more data requests, at least one of the data requests comprising a request for a value at risk report regarding the portfolio; and (d) software operable to provide a value at risk report based on the background data, the calculations, and the configuration data, wherein the value at risk report is based on a Parkinson's volatility estimation.
In various embodiments: (1) the software operable to acquire background data is operable to obtain real-time data regarding positions from one or more order management systems; (2) the software operable to acquire background data is operable to obtain real-time pricing data from one or more market data services; (3) the software operable to acquire background data is operable to obtain high-low volatility data based on a plurality of recent trading days; (4) the plurality of recent trading days is approximately ten days; (5) the software operable to perform calculations regarding intermediate measures of performance of the securities is operable to compute implied volatility for options based on a Black-Scholes formula and market prices; (6) the software operable to perform calculations regarding intermediate measures of performance of the securities is operable to compute multi-point risk arrays based on option implied volatility and stock high-low volatility; (7) the software operable to receive configuration data for a portfolio of securities is operable to receive the calculated intermediate measures of performance; (8) intermediate measures of performance comprise positions, volatilities, and risk arrays; (9) the software operable to provide a value at risk report is operable to group positions by underlying securities; (10) the software operable to provide a value at risk report is operable to aggregate risk arrays; (11) the software operable to provide a value at risk report comprises aggregating risk arrays for futures positions within each of one or more portfolios and applying correlation coefficients; and (12) the software operable to provide a value at risk report is operable to transmit the report to a graphical user interface for display.
In another aspect, the invention comprises a method comprising: (a) implementing a variance-covariance model; (b) calculating a Parkinson's volatility approximation with intra-day adjustments; (c) performing a periodic batch option revaluation based on a Black-Scholes model; (d) modeling a multi-point risk array for intermediate measures of theoretical prices; (e) estimating correlations based on a multivariate model; (f) implementing quadratic regression for delta/gamma estimation; and (g) generating a value at risk report.
In various embodiments: (1) for each of one or more positions in the portfolio, one or more elements of a corresponding risk array are computed based on a product of price, volume, and risk array elements for the security in which the position is held; (2) quadratic regression is performed on data points derived at least in part from the risk array; (3) values of securities in the portfolio are assumed to be log normally distributed; (4) derivatives in the portfolio are assumed to be non-linearly distributed; (5) zero correlation is assumed among assets in different asset classes; (6) correlation of 0.5 is assumed among assets within an asset class; (7) high correlation is assumed for assets with the same underliers; (8) the value at risk report comprises three levels: portfolio, underlier group, and position; and (9) a √{square root over (T)} rule is used to estimate daily volatility intraday.
In another aspect, the invention comprises software comprising: (a) software operable to implement a variance-covariance model; (b) software operable to calculate a Parkinson's volatility approximation with intra-day adjustments; (c) software operable to perform periodic batch option revaluation based on a Black-Scholes model; (d) software operable to model a multi-point risk array for intermediate measures of theoretical prices; (e) software operable to estimate correlations based on a multivariate model; (f) software operable to implement quadratic regression for delta/gamma estimation; and (g) software operable to generate a value at risk report.
In various embodiments: (1) for each of one or more positions in the portfolio, one or more elements of a corresponding risk array are computed based on a product of price, volume, and risk array elements for the security in which the position is held; (2) quadratic regression is performed on data points derived at least in part from the risk array; (3) values of securities in the portfolio are assumed to be log normally distributed; (4) derivatives in the portfolio are assumed to be non-linearly distributed; (5) zero correlation is assumed among assets in different asset classes; (6) correlation of 0.5 is assumed among assets within an asset class; (7) high correlation is assumed for assets with the same underliers; (8) the value at risk report comprises three levels: portfolio, underlier group, and position; and (9) a √{square root over (T)} rule is used to estimate daily volatility intraday.
In another aspect, the invention comprises software comprising: (a) software for displaying a first portion of a graphical user interface display comprising a tree structure display; and (b) software for displaying a second portion of a graphical user interface display comprising a tabular display, wherein one or more items in the tree structure display, when selected by a user, each have corresponding listings displayed in the tabular display, and wherein one or more of the listings in the tabular display, when selected by a user, each causes a corresponding item in the tree structure to be displayed.
In various embodiments: (1) items in the tree structure display are selected using checkboxes; (2) listings in the tabular display are selected using highlighting; (3) the tree structure display represents a multi-level hierarchy; (4) for each of one or more selected items in the tree structure display, a corresponding listing in the tabular display comprises hierarchical properties of the one or more selected items in the tree structure display; (5) at least one level of the hierarchy corresponds to one or more banks; and (6) one or more items in the tree structure corresponds to an account.
In another aspect, the invention comprises a method comprising: (a) displaying a tree structure display in a first portion of a graphical user interface display; (b) in response to a user selecting an item from the tree structure display, displaying a corresponding listing in a tabular display in a second portion of the graphical user interface display; and (c) in response to the user selecting a listing in the tabular display, displaying a corresponding item in the tree structure display.
In various embodiments: (1) items in the tree structure display are selected using checkboxes; (2) listings in the tabular display are selected using highlighting; (3) the tree structure display represents a multi-level hierarchy; (4) for each of one or more selected items in the tree structure display, a corresponding listing in the tabular display comprises hierarchical properties of the one or more selected items in the tree structure display; (5) at least one level of the hierarchy corresponds to one or more banks; (6) one or more items in the tree structure corresponds to an account.
In another aspect, the invention comprises a method comprising: (a) computing one or more net asset values for an account based on a broker-dealer's margin rule settings; (b) computing one or more margin requirements for the account based on the margin rule settings; (c) computing account buying power based on the one or more margin requirements and one or more net liquidation values; and (d) displaying on an account summary screen computed results for the one or more net asset values, the one or more margin requirements, and the account buying power.
In another aspect, the invention comprises: (a) software operable to compute one or more net asset values for an account based on a broker-dealer's margin rule settings; (b) software operable to compute one or more margin requirements for the account based on the margin rule settings; (c) software operable to compute account buying power based on the one or more margin requirements and one or more net liquidation values; and (d) software operable to display on an account summary screen computed results for the one or more net asset values, the one or more margin requirements, and the account buying power.